The following are the basic decision-making indicators in Marginal Costing:

1. Profit Volume Ratio (PV Ratio) / Contribution Margin ratio

2. Break-Even Point (BEP)

3. Margin of Safety (MOS)

4. Indifference Point or Cost Break-Even Point

5. Shut-down Point

PROFIT/VOLUME RATIO (P/V) RATIO

A profit-Volume ratio expresses the relationship between contribution and sales. It indicates the relative profitability of diff products, processes, and departments. Higher the P/V ratio, more will be the profit, and lower the P/V ratio lesser will be the profit. Hence, it should be the aim of every concern to improve the P/V ratio which can be done by increasing selling price, reducing variable cost, etc.

The Profit/volume ratio, which is also called the ‘contribution ratio’ or ‘marginal ratio’, expresses the relation of contribution to sales and can be expressed as under:

P/V Ratio = Contribution/Sales

Since Contribution = Sales – Variable Cost = Fixed Cost + Profit, P/V ratio can also be expressed as:

P/V Ratio = Sales – Variable cost/Sales i.e., S – V/S

or, P/V Ratio = Fixed Cost + Profit/Sales i.e. F + P/S

or, P/V Ratio = Change in profit or Contribution/Change in Sales

This ratio can also be shown in the form of percentage by multiplying by 100. Thus, if the selling price of a product is Rs. 20 and the variable cost is Rs. 15 per unit, then

P/V Ratio = 20 – 15/20 × 100 = 5/20 × 100 = 25%

The P/V ratio, which establishes the relationship between contribution and sales, is of vital importance for studying the profitability of operations of a business. It reveals the effect on profit of changes in the volume.

In the above example, for every Rs. 100 sales, a Contribution of Rs. 25 is made towards meeting the fixed expenses, and then the profit comparison for P/V ratios can be made to find out which product, department, or process is more profitable. Higher the P/V ratio, more will be the profit, and lower the P/V ratio, lesser will be the profit. Thus, every management aims at increasing the P/V ratio.

The concept of P/V ratio is also useful to calculate the break-even point, the profit at a given volume of sales, the sales volume required to earn a given (or desired) profit, and the volume of sales required to maintain the present profits if the selling price is reduced by a specified percentage.

Uses of P/V Ratio:

1. To compute the variable costs for any volume of sales.

2. To measure the efficiency or to choose the most profitable line. The overall profitability of the firm can be improved by increasing the sales/output of a product giving a higher PV ratio.

3. To determine the break-even point and the level of output required to earn the desired profit.

4. To decide more profitable sales mix.

Illustration 3.

Calculate p/v ratio from the following

Given the selling price of $10 per unit, the variable cost per unit is $6

Given the profit and sales of two periods

Year	SALES	PROFIT
	AMOUNT	AMOUNT
2004	1,50,000	20,000
2005	1,70,000	25,000